A tip for concessional caps

Since July 1, 2007, superannuation contributions have been subject to contribution caps, with strict penalties in place where these limits are exceeded.

Due to these tax penalties, a great deal of focus has been placed on monitoring superannuation contributions, particularly concessional contributions.

However, despite these penalties, there is an argument for certain individuals to breach their concessional contributions cap to take advantage of a tax effective way to fund their insurance premiums.

To better understand this opportunity and its benefits, let’s start with a quick refresher of how the concessional contributions cap and the associated tax penalties are applied.

Concessional contributions cap

Concessional contributions are generally contributions that attract the 15 per cent contributions charge (tax), including superannuation guarantee, salary sacrifice and any personal contributions for which a tax deduction is allowed.

These contributions are subject to the concessional contributions cap of $50,000 per person, per financial year. However, a transitional cap of $100,000 is available for individuals who are aged 50 or over at the end of the particular financial year during the transitional period. This transitional period ends on June 30, 2012.

Importantly, the concessional contributions cap does not limit the size of the tax deduction available to an employer for super contributions made on behalf of an eligible employee. Nor does it limit the size of the tax deduction an individual can claim for personal contributions where they meet the less than 10 per cent eligibility criteria.

Any concessional contributions made or received by an individual in excess of the concessional contributions cap will be subject to an additional penalty tax of 31.5 per cent. This penalty is applied in addition to the 15 per cent contributions charge (tax) already levied by the super fund and can be paid by the individual out of his/her own pocket or from their super account.

Also, any excess concessional contributions will be counted towards the individual’s non-concessional contributions cap.

Intentionally breaching the concessional cap

Admittedly, the tax penalty associated with a breach of the concessional contributions cap often makes it difficult to justify making or receiving concessional contributions above this cap.

However, the way this tax penalty is applied creates an opportunity for certain individuals to benefit from breaching the concessional contributions cap when funding life insurance premiums for cover held within their fund.

How does it work?

It is not uncommon for individuals to hold their life, total and permanent disablement and/or salary continuance insurance cover through their superannuation fund. In such circumstances, the policy is owned by the superannuation fund trustee, who is responsible for making premium payments.

From a practical perspective, these premiums are commonly funded by the individual making concessional contributions such as salary sacrifice or personal deductible contributions.

As these are concessional contributions, it is important to remember that they will be counted towards the individual’s concessional contributions cap and that any excess concessional contributions (ie. above the individual’s cap) will attract the 31.5 per cent penalty tax rate.

Interestingly though, the insurance premiums paid by the fund will generally result in a tax deduction to the superannuation fund. Where concessional contributions are used to fund these insurance premiums, they will not attract the 15 per cent contributions charge (tax), as the fund will, in turn, claim a tax deduction for these amounts.

As such, removing the 15 per cent contributions charge (tax), these excessive concessional contributions will now only incur the 31.5 per cent excess concessional contributions penalty tax.

When we consider individuals who are on a 41.5 per cent marginal tax rate or above, this creates a tax efficient way to fund their insurance premiums while maximising the level of concessional contributions they are able to make/receive.

Note: This strategy is not suitable where the individual in question is approaching their non-concessional contributions cap. A breach of both these caps will result in a 78 per cent tax penalty.

John Perri is the technical services manager at AMP.